Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

PayPal's Hidden Growth Potential Makes It a Buy

Three reasons why PayPal's "true" revenue growth might be higher than it appears.

When PayPal Holdings(NASDAQ:PYPL) reported its 2019 first-quarter results, everything seemed to be business as usual:

Solid top- and bottom-line growth. Revenue rose to $4.13 billion, a 12% increase year over year, while adjusted earnings per share grew to $0.78, a 37% increase over 2018's first quarter.

More than 9 million new accounts were added on top of a high-single-digit percentage increase in user engagement.

The potent combination of more users using the digital payment platform continues to drive payment volume. In Q1, the number of transactions facilitated across PayPal's platform rose to 2.84 billion, a 28% increase year over year, and total payment volume increased 25% to $161.5 billion.

As I said, for PayPal, this solid to strong growth across every key metric is business as usual. Quarter in and quarter out, it's difficult to find another company that performs so consistently. And yet, as good as these numbers are, I believe PayPal's "true" growth is even better than the headline numbers show. In fact, I believe three factors are acting to conceal how fast PayPal's core business is growing and making PayPal appear more expensive relative to growth than it really is.

Allow me to explain.

PayPal's eBay business continues to matter less and less. In Q1, for the first time ever, eBay accounted for less than 10% of total payment volume. Image source: PayPal Holdings.

The sale of PayPal's credit portfolio

Last year, PayPal finalized the sale of its personal credit portfolio to Synchrony Financial(NYSE:SYF) for $6.9 billion. The deal with Synchrony appears to be one of those rare instances of both companies winning. For PayPal, the sale allowed it to remove the vast majority of credit exposure facing the company and gave it cash, which it used to make a series of smart acquisitions last summer. For Synchrony, the purchase allowed it to grow its loan portfolio by 9% overnight, all while servicing the loans at a lower cost than PayPal could due to the sheer size of its loan portfolio.

While the deal made a lot of sense for PayPal, unloading the loans from its balance sheet did mean that it was no longer going to be able to collect the interest from the loans. This quarter, that loss in revenue negatively affected PayPal's revenue growth by 7 percentage points. In other words, PayPal's total revenue growth would have been 19%, not 12% as reported, if the sale to Synchrony had never gone through.

eBay's slowing business

PayPal is still processing eBay's (NASDAQ:EBAY) transactions, as part of an agreement the two companies signed prior to splitting up. Last year, eBay announced it would not be renewing the deal when the contract expired in 2020. (Importantly, this does not mean that PayPal will not be available as a payment method for eBay's buyers and sellers, only that PayPal will not be responsible for processing eBay's transactions.)

When the deal expires next summer, PayPal management expects eBay payment volume to represent about 5% to 6% of its total payment volume. Currently, eBay makes up close to 10% of PayPal's volume. What accounts for the difference? In Q1, eBay's payment volume declined by 4% while the rest of PayPal's payment volume screamed higher at a 29% clip.

Venmo keeps growing

The third and final thing hiding PayPal's growth potential is the continued growth of monetized activity on Venmo. In Q1, PayPal revealed there were more than 40 million active Venmo users, the first time this number was made public. Total payment volume rose on the social media-like payment platform to $21 billion, a 73% increase year over year. Management projected that volume could reach close to $100 billion for 2019.

The real story, however, is the revenue this platform is just beginning to generate for PayPal. In Q1, the annualized revenue run rate for Venmo was $300 million; last quarter it was $200 million. Venmo can generate revenue the way most digital payment platforms can, through things such as instant transfers, paying for products or services, or using the Venmo debit card. However, don't underestimate the powerful potential marketing force a payments platform with a social media element to it can possess.

[I]n the first quarter, we launched a customer engagement partnership with Chipotle. Engaging customers through Venmo payouts to drive awareness for their new rewards program. In the less than one week, they surpassed their launch campaign objective with 1 million sign-ups. And this is just the beginning of brands leveraging Venmo to drive engagement and conversation within the social feed.

Venmo is a revenue stream that has not even begun to be tapped, but it holds worlds of potential. As Venmo's potential is unleashed, do not be surprised to see PayPal's revenue reaccelerate.

PayPal's hidden growth revealed

Once these factors are considered, I believe PayPal's 12% revenue growth can be seen for what it really is: a placeholder for higher revenue growth rates to come. Once the sale of PayPal's credit portfolio to Synchrony Financial is lapped, eBay's business is removed from the books, and Venmo begins generating revenue in earnest, PayPal's revenue growth should reaccelerate.

For all these reasons, PayPal is a greater growth story than what appears at first glance and remains a large position in my own personal portfolio.

Author

As an economic crimes detective, Matthew focuses on helping others avoid becoming victims of fraud and scams. He is most familiar with the fintech and payments industry and devotes much of his writing to covering these two sectors.
Follow @FoolMCochrane